Are Incentive Contracts Rigged by Powerful CEOs?

ABSTRACT

We argue that some powerful CEOs induce boards to shift the weight on performance measures toward the better performing measures,
thereby rigging incentive pay. A simple model formalizes this intuition and gives an explicit structural form on the rigged incentive portion
of CEO wage function. Using U.S. data, we find support for the model’s predictions: rigging accounts for at least 10% of the
compensation to performance sensitivity and it increases with CEO human capital and firm volatility. Moreover, a firm with
rigged incentive pay that is one standard deviation above the mean faces a subsequent decrease of 4.8% in firm value and 7.5%
in operating return on assets.